Financial Management

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Financial Management

• Returning To The Farm
• University of Nebraska-
  Lincoln

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Assets

• Things Of Value Owned By The Business
• Tangible (Real Estate, Inventory)
• Intangible (Intellectual Property)
• Current Assets Are Assets That Can Be Converted
  To Cash Within A Year
• Cash
• Accounts Receivable (A/R)
• Inventory

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Current Assets
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Assets

• Fixed Assets Provide Benefit To Business For More
  Than 1 Year
• Buildings
• Equipment
• Land
• Liquidity Speed Ease An Asset Can Be
  Converted To Cash. (Intermediate or Long Term)
• Ease Of Conversion vs. Loss Of Value
• Tractor vs. Custom Hog Finishing Unit vs. Land

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Intermediate Term Assets
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Long Term Assets
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Non-Farm Assets
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Liabilities

• Obligation To Pay A Debt
• Current Liabilities Generally Must Be Paid Within
  1 Year
• Accounts Payable
• Current Years Principle Payment On Loan
• Taxes Payable

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Current Liabilities
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Liabilities
Term Liabilities Are Obligations That Are Due
After 1 Year Intermediate -Term Bank Notes 2 to
10 Year Long-Term Bank Notes 10 or
more Contracts
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Term Liabilities Intermediate
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Term Liabilities Long
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Non-farm Liabilities
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Owners Equity (Net Worth)

• Estimate Of The Business Value That Would Be
  Transferred To Owners If All Assets Were
  Liquidated All Liabilities Paid
• Increased By Invested By Owners Or Made In The
  Business And Decreased By What Owners Withdraw
  From The Company Or The Business Lost

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The Balance Sheet

• Summary Of Businesss Assets, Liabilities, Net
  Worth
• Assets Are Arranged From Most Liquid To Least
  Liquid
• Statement Of The Financial Condition Of A
  Business On A Specific Date
• Should Be Prepared At Least Once A Year, Usually
  At The End Of The Fiscal (Calendar) Year

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The Balance Sheet
Owners Equity (Net Worth)
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Assets Liabilities Owners Equity

• Two Groups Can Make Claims Against The Business
• Creditors
• Owners
• Creditors, Legally, Are Entitled To The First
  Claim
• The Balance Is The Owners Equity
• If Liabilities Exceed Assets
• Owners Equity Is Negative
• Firm Is Insolvent
• Could File For Bankruptcy

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Balance Sheet

• For Trend Analysis
• Complete At Same Time Each Year
• Value Assets Same Way Each Year
• Asset Valuation
• Cost
• Cost Less Depreciation
• Market Value

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Balance Sheet Trend Analysis Multi-year look
at the Direction of progress In financial
performance
Measure progress in Net Worth
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The Income Statement

• Summarizes Farms Revenues Expenses Over A
  Given Period Of Time
• Provides Measurement Of Profit
• Should Be Prepared At Least Once A Year, Although
  May Prepare More Frequently

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The Income Statement

• Revenue Amount Received (Or To Be Received)
  From Selling Grain or Livestock, Government
  Program Benefits, or Services Provided
• Expenses Amount Paid (Or To Be Paid) For Inputs
  Used In Production, Labor Management Costs,
  Noncash Items (e.g., Depreciation)

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The Income Statement

• Net Income What Is Actually Made By The Farm
  Business After All Expenses Are Paid
• Net Income Revenue - Expenses

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Comparative Statements Analysis

• Compare Documents From One Period To The Next, Or
  To Budgeted Amounts
• Are There Major Changes?
• What Caused The Changes?
• Calculate Difference In Absolute Percentage
  Terms

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Income and Expense Trend Analysis
Net Farm Profit /-
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Working Capital

• Money Used To Meet Daily Emergency Expenses
• Measure Of Liquidity
• WC Current Assets Current Liab.
• Guidelines
• Green WC or gt than Current Liabilities
• Yellow WC lt Current Liabilities but gt 0
• Red WC lt 0

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Rationale for Ratio Analysis

• Financial Statements Are Only Numbers On Paper
• Measure Health Of The Business
• Compare Over Time, One Farm To Another, Or
  Against Benchmarks
• Means To Control The Firm
• Easily Understood
• Communicate To Interested Parties Outside
  Management (e.g., Lenders)

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Ratio Analysis

• Easy To Calculate, Compare, Understand
• Four Categories Of Financial Ratios
• Liquidity
• Solvency
• Efficiency
• Profitability

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Liquidity Ratios

• Measures The Ability To Pay Bills Or Short Run
  Obligations
• Working Capital
• Current Ratio

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Current Ratio

• Formula Current Assets
• Current Liabilities
• Function Measure Of Short-Term Liquidity
• Guideline
• Green gt 1.5
• Yellow 1.0 -1.5
• Red lt 1.0
• Improve By Current Assets Or Current
  Liabilities

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Solvency Ratios

• The Ability To Pay Debt Or Long Run Obligations
• Debt To Asset Ratio
• Equity To Asset Ratio
• Debt To Equity Ratio (Leverage)

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Debt To Asset Ratio

• Formula Total Liabilities
• Total Assets
• Function Measures How Much Of The Assets Lenders
  Are Capitalizing How much your lenders own of
  your business
• Guideline
• Green lt 0.3
• Yellow 0.3-0.7
• Red gt 0.7
• Improve By Liabilities Or Total Assets

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Equity To Asset Ratio

• Formula Total Equity
• Total Assets
• Function Measures How Much Of The Assets Are
  Funded By Owner Capital
• How much you own of your business.
• Guideline
• Green gt 0.7
• Yellow 0.7-0.4
• Red lt 0.4
• Improve By Equity Or Total Assets

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Debt to Equity (Leverage) Ratio

• Formula Total Liabilities
• Net Worth (OE)
• Function Determine Size Of Debt, Measures
  Leverage
• Guideline
• Green lt0.43
• Yellow 0.43-1.5
• Red gt 1.5
• Improve By Liabilities And Net Worth

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Efficiency Ratios

• Relative Activity Of The Farm With Respect To Its
  Assets, Inventory Levels, Customer Credit
  Payments, Its Own Bill Paying
• Asset Turnover

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Asset Turnover Ratio

• Formula Gross Revenues
  Total Assets
• Function Measure Intensity Of Asset Use
• Guideline
• The Higher The Better
• Varies Across Industries Even Farm Enterprises

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Asset Turnover Ratio Benchmarks
Enterprise Green Yellow Red
Cow-Calf gt0.20 0.07-0.20 lt0.07
Swine gt1.10 0.60-1.10 lt0.60
Cash Grain gt0.35 0.20-0.35 lt0.20
Feedlot gt1.50 0.90-1.50 lt0.90
Dairy gt1.10 0.85-1.10 lt0.85
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Profitability Ratios

• Indicator Of Businesss Profitability
  Performance
• Return On Equity
• Return On Assets
• Operating Profit Margin Ratio

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Operational Ratios
Except depreciation interest

• Operating Expense Operating Exp
• Gross
  Revenues
• Depreciation Expense Depreciation Exp
• Gross
  Revenues
• Interest Expense Interest Exp
• Gross
  Revenues
• Net Income Ratio Net Income
• Gross
  Revenues
• These Should Add Up to 1.0

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Return on Equity (ROE)

• Formula Net Profit
• Total Equity
• Function Measures How Owners Fared During The
  Year In Exchange For Letting The Farm Use Their
  Money
• If The Return On Equity Is 10, Then .10 Of
  Profits Are Created For Each 1 That Was
  Invested.
• Guideline Will Vary Can Range From To

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Return on Assets (ROA)

• Formula (Net Profit Interest)
• Total Assets
• Function Measures How Owners Lenders Fared
  During The Year In Exchange For Letting The Farm
  Use Their Money
• Add Back Interest Because It Is Lenders Payment
• Guideline
• Green gt0.05 (owned) gt0.12 (rented)
• Yellow 0.01-0.05 (owned) 0.03-0.12 (rented)
• Red lt0.01 (owned) lt0.03 (rented)

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Operating Profit Margin Ratio

• Formula
• Net Income Interest Exp Unpaid
  Family Labor Mgmt
• Gross Revenue
• Function Measures Return To Farm After Operator
  Family Labor Mgmt Claims That Can Be Used For
  Growth

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Summary

• Using These Ratios Will Aid Management In
  Understanding Their Farms Financial Health
  Performance.
• Cannot Just Look At Ratios Alone ? Treat Them As
  Indicators